5 Things You Don’t Know About Your 401(k)

Remember when you got your first job with benefits? Life was good; you were excited about the work. Your employer put a bunch of paperwork in front of you, and you signed things, and at the end of it, (1) you had a job, and (2) you had a retirement account! Sweet! 😎

Your employer even told you that not only were you saving for retirement, you were also saving on taxes, and you were getting free money- the employer was matching some of your contribution into your 401(k). Even more awesome 🤯

And yes, those are amazing advantages. Save for your future- check- super important. Saving on your taxes- that always sounds good. And the best part is, did we mention the free money? Just show up for work when you’re supposed to, and your employer gives you money over and above your paycheck 👍

There is nothing wrong with any of this! But it is not a complete picture of how your 401(k) works. It could be a 403(b), an IRA, or any other employer-sponsored retirement account (ESRA), so we’ll stick to referring to ESRAs for simplicity’s sake. And since we dive into the super cool financial issues, we’re going to examine ESRAs today 🙂

5 Super Cool Positive Things About Your ESRA

We mostly covered these already, so here goes:

1. Free Money. Your employer contributes (matches) a certain amount of your contribution. These matches are less generous than they used to be, but never, ever say no to free money. Unless it comes from a Nigerian prince 🤨

2. Pre-Tax Money. You don’t pay taxes on that money before it’s contributed. That turns into a tax deduction, which can lower your tax bracket, and thus your taxes for that year 😄
   This is what the IRS calls a “tax advantaged” plan. I don’t agree with that word, but that’s what the IRS means when they use that term, and if you want to know a more in-depth take on it, read more here.

3. Set It and Forget It. You never see that money; it never goes into your bank account. You will save more over your lifetime when you save first, not spend first and see “what’s left over” for saving 📈
   It’s so easy! The easiest way to save money is to get someone else to do it for you- your employer! And they’re giving you free money for the privilege 😆

4. Employer Managed Growth. Your employer has hired a money management firm to manage all the ESRAs they hold. Your ESRA savings gets invested in the stock market, bonds, etc; and if you don’t know how to (or don’t want to) decide where your money gets invested, you don’t have to- the employer’s money manager does it for you 😉
   Bonus- you do have the flexibility to decide where your money gets invested, if you do want to! Employers nowadays have portals where you can log in and easily move your money to stocks, mutual funds, etc, that you want to support 👍

5. Historic Market Growth. Before 401(k)s were popular- this was back when pensions were more common- only about 30% of Americans were stock owners. Today? It’s almost twice as many- 55%- and that’s due to the rise of the 401(k) and other ESRAs. And it’s good for the economy! Pouring that money into the market made the market soar from the late 1970s to the early 2000s- money begets money 📈

The Deeper Dive- 5 Things Your Employer Won’t Tell You About Your ESRA

These aren’t negative facets of ESRAs; they’re simply things that most people don’t know- because who’s going to tell you? It’s not your employer’s job; it’s not their money manager’s job; your parents/friends probably don’t know this stuff; and your own money manager doesn’t usually have the incentive to do so. But they’re important anyway, and you’re learning them here!

1. Fees. How much are you paying in fees? The average worker will pay $138,336 in 401(k) fees over their working lifetime. Percentage-wise, it’s an average of 2.2% per year, but it can range from 0.45% to 5%. Wow that’s a lot 😲
   And remember, those fees are deducted from your account balance- you are paying this money manager, not your employer- even though it’s your employer who chooses the money manager 🤔
   In addition, you will always pay these fees, whether your accounts wins or loses. When your account loses, you will of course pay a smaller dollar amount of fees… but you’ll be paying the same percentage 😖
   So, you have no control over how much you’re paying in fees… and you have no control over who is managing your money… and you pay those fees whether the manager improves or impoverishes you 😨
   But have no fear! There are solutions 😊

2. More Taxes Overall. You know that free money you got when your employer matched your contribution? It’s still free, don’t worry… but did you ever think about why your employer wants to give you money above and beyond your salary? It’s a nice incentive, but it’s not just out of the goodness of their hearts- it’s also because they get a tax break out of it. The employer gets to deduct their contribution, just like you get to deduct your contribution. And both of those deductions mean…
   Remember, Uncle Sam always gets his cut 🤨
   Think about it: You (and your employer) are saving on your taxes in the year you contribute that retirement money; you don’t really think that Uncle Sam just wants to help a fella out and give you a break, do you? Nope, not a chance! The flip side of “save on taxes now”, is “pay more taxes later”.
   The basic idea- that you put your money into your ESRA, and let it grow so you can live on it in retirement- is great. But you will have to pay income tax on ALL that money when you withdraw it in retirement- yes, even on the money that your employer contributed for you 😲😖
   Here’s an analogy- if you own a field, and you want to plant corn on that field, you have to pay taxes on that corn somehow. An ESRA says “you don’t have to pay sales taxes on the seed corn you plant”… you’ll pay taxes on ALL the corn once you harvest it 😰
   Well, what’s the alternative? Can you say, “May I please pay sales taxes on the seed corn, so I don’t have to pay taxes on all the corn I can harvest?” The answer is yes, indeedy 😄❕

3. Bad Stuff Happens To It When You Leave Your Job. Most people don’t think about taking their ESRA with them when they leave a job- some people don’t even realize they can! 🤔
   But just because your employer sets it up, and sets up the manager for it… well it’s still not their money, right? But it’s also not their job to remind you about your ESRA, or even to tell you how to roll over that money to another account, when you find a new job and are leaving them.
   And why would you think to do so? Most people assume that their money is sitting, safe and tidy, in the same account, with the same manager, and is growing nicely on the sidelines 👍
   Au contraire, friend. When you leave an employer, several things happen:

   1. You lose access to the employer portal to manage your own investment allocations. Want to get out of oil and gas and into solar power? Can’t. Want to change from more aggressive to more conservative? Can’t 🤷

   2. Your investment allocations don’t change, period. Not only can you not choose to change your investment allocations anymore, but the money manager will never do it for you of their own volition. Why would they? You’re no longer employed there; you’re not going to complain to the employer that your account is being mismanaged 🤷

   3. Fees can go up- quite a bit. Once you leave an employer, they may charge extra fees for managing the money of someone who is no longer an employee- your employer isn’t going to pay for someone to actively manage your money once you no longer work there, you know 🤷

   One poor colleague of mine lost $200,000 over a 20 year period- he assumed that his retirement money was growing on its own, and he should leave it alone and let it grow in peace. Twenty years after leaving his employer, he got a check in the mail for… less than six dollars. His account had dwindled to nothing, because his fees had been raised so high over time that it killed his retirement savings 😖😨😭
   But it is your money, and it’s portable. There are solutions…

4. You Can Lose Money. A Lot of Money. More Money Than You Think. This one might seem obvious: Your ESRA is invested in the stock market, and the stock market goes up and down. That means that the value of your ESRA goes up and down. I know, I know- you know this part already 😁👍
   But here’s the interesting part:
   In 2008, it took five years for people to get back to even after their initial losses. “Oh no, that wasn’t me!” you say. “My account got back to even way sooner than 5 years. My employer clearly had a much better money manager than average, and they took care of me- I did fine.”
   So… Um… Were you still contributing to your ESRA after 2008? 🤔
   Of course you were, and your employer was contributing, too 😁
   Wait… 😕😔😖
   In this case, “making up your losses quicker than the average,” actually means “you paid your account back for the losses it incurred.” You weren’t paying yourself/saving for your future; you were paying off your losses. This thought always makes me physically wince 😬
   Sometimes I tear up, when I think about how much people lost- and they felt like their money was growing- when it was really just their own contribution money they were looking at on their account statements 😢
   And don’t forget, you’re paying your money manager a fee this whole time! It’s a smaller amount, when your account loses money… but you’re still paying them, whether they grow or lose your money 😨

5. Rules and Limits. Last thing- since the IRS is “helping” you by giving you a tax break, they want to limit how you can utilize that “tax break”. (Of course they do.) Enter the Required Minimum Distribution (RMD), contribution limits, and early-withdrawal penalties.

   1. RMD rules state that you must withdraw a certain amount of your retirement money every year after you turn 72. This seemed like a super reasonable, easy-to-follow rule, back when the average American kicked the bucket at 75 or so. Now, with us living longer… it’s less reasonable 🤨
      Especially since RMDs are usually around 4% of your total retirement holdings… and most money managers advise that you should only withdraw about 3% of your savings per year, or you might run out of money before you kick your oxygen habit 😳

   2. In addition to the rather burdensome RMD rules, there are contribution limits to how much you can put into your ESRA every year. Uncle Sam wouldn’t want to give you too much of a tax break, you know 😆

   3. And, third, RMDs may be required if you live too long and don’t withdraw… but you will also pay pretty stiff penalties if you need your money before retirement. Uncle Sam has decreed both that “you should save for retirement, so here’s a tax break when you’re young”, and also that “we need our tax money, so you can’t hoard your money or live frugally when you’re old”, but additionally, Uncle Sam wants you to know that if you choose to (have to?) withdraw money before 59 1/2, you’ll be punished 😨
      Unless you can prove you are suffering from a short list of extremely bad circumstances- paperwork, here we come! 📜🤓

Ugh. Have you read your own article? Stop being depressing, Melissa.

Okay! 😀👍

I am sorry. I don’t think this stuff is depressing, because I like knowing more. But that’s a lot of negatives, right? Sorry!!! 😮

Let’s get back to the big points: ESRAs have a lot of good qualities. They put millions of Americans into the “I am an investor” niche; they help you save on taxes in the year you contribute; and best of all, they are dead easy to contribute to and to manage, because you’re not doing any managing- your employer is! 😁

And now you’ve had the behind-the-scenes look at the hidden truths behind how ESRAs really operate. You know more about ESRAs than most Americans, and to top it all off, you’re going to LOVE our next Smart Money Minute- the 5 Tips to Get the Most Bang for your Buck in your ESRA 😍

Now That’s Smart Money 🧐